Delta’s Alliance with Aeromexico Could Boost International Growth

Delta Air Lines (NYSE:DAL), the world’s largest passenger airline by available seat miles (ASM), announced plans to enter into an exclusive long-term commercial partnership with Grupo Aeromexico (Mexico:AEROMEX) early last month. The agreement includes network-wide code sharing arrangements as well as a commitment by Delta to invest $65 million in the Mexican airline that will lead to the combined Aeromexico and Delta overtaking United-Continental as the largest player in the US-Mexico market. Delta competes with Southwest Airlines (NYSE:LUV), American Airlines (NYSE:AMR), US Airways (NYSE:LCC ) and United Continental (NYSE:UAL) in the domestic market and faces stiff competition from alliances like Star and Oneworld internationally.

We decided to take a closer look to understand the implications of the partnership for Delta’s valuation. We value Delta Air Lines with a $9 Trefis price estimate, implying a premium of ~20% over the current market price.

What does the proposed agreement entail?

The agreement enables network-wide codesharing for both Delta and Aeromexico flights between the U.S. and Mexico as well as flights within the carriers’ domestic networks and to other key international destinations.

The cooperation further includes setting up a coordinated sales team, reciprocal benefits for elite-level loyalty program members and a $65 million investment by Delta in Aeromexico. The investment once approved by the Mexican regulators would give Delta a ~3.6% stake in Grupo Aeromexico and a seat on its board of directors.

How does the partnership benefit Delta?

1) Expansion into the international markets including Latin American markets through code sharing

Delta and Aeromexico are both part of the SkyTeam alliance and have about 500 code shares that would rise to 700 under the enhanced partnership. This will aid Delta in expanding its presence in the fast-growing Latin American markets. Though Delta’s Latin America business is small, accounting for around ~6% of Delta passenger revenues, it has been growing at a nice pace when compared to other regions.

With favorable macroeconomic factors like increasing trade volumes between the North American nations (roughly $400 billion in 2010), Mexico’s  high ranking as the third largest U.S. trading partner and with Delta trimming its flights to Europe, an expansion into Mexico and South America could be a lucrative opportunity.

2) Improved customer service through expanded customer benefits

By leveraging strength of the alliance, Delta can now improve its customer service by offering additional customer benefits such as support from coordinated sales team that offers joint contracting to corporate customers allowing enhanced access to the combined networks, expedited call handling for Elite customers through a new, integrated process, co-located airport facilities for easier connections and the facility to select preferred seat assignments, process upgrades and redeeming Award Tickets online.

What are the implications for Delta’s valuation?

1) Increased International Market Share

Aeromexico accounts for 16% of all seats between the US and Mexico while Delta accounts for 8.6% giving the two a combined market share of 24.6% in the US-Mexico market that is higher than the current leader, United -Continental’s share of 23.6% of the US-Mexico capacity. The company officials said that they intend to increase this combined market share by 10%.

The scheduled traffic carried by Delta on the US-Mexico route is currently a very small and insignificant percentage of the total traffic for Delta and boosting this to the tune of 10% would not have any tangible impact on the share price.

However, as Delta eventually grabs a bigger share of US-Mexico market and other international markets as a result of the partnership, its international market share could increase to impact its stock price meaningfully.

2) Higher Average International Occupancy Rate

Due to codesharing, Aeromexico would also be able to expand its global reach by utilizing Delta’s routes. This would in turn help Delta in increasing its average occupancy rate, thereby improving the load factors. Also, the slew of customer benefits introduced under the agreement should help Delta attract higher passenger traffic.

The above factors are likely to improve Delta’s valuation, as growth in overall traffic and higher load factors translate into a higher share price with the execution of the agreement.

See our complete analysis for Delta’s stock